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The S&P Downgrade and the Folly of Conventional Wisdom

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In its controversial decision to downgrade U.S. bonds, Standard & Poor's embraced the "conventional wisdom" calling for substantial cuts in government spending. Conventional wisdom, however, usually is more of a reflection of prevailing dogma than actual wisdom and, in the words of John Kenneth Galbraith, merely "serves to protect us from the painful job of thinking." The decision by S&P's Managing Director, John Chambers, who never studied economics but instead holds an M.A. in English literature, was no different, as it elevated talking points over analysis and spin over substance (while admittedly being off by $2 trillion in its analysis).

As odd as it may sound in 2011, this debate ultimately is a continuation of the debate over whether the New Deal succeeded in rescuing the U.S. economy from the Great Depression. Republican talking points are that the New Deal exacerbated the Depression and only the advent of World War II saved the U.S. economy. The reality is that Roosevelt began righting the ship of state from the onset with over 50 percent GDP growth in his first term. Where Roosevelt faltered, however, was in his second term when he cut spending to appease Republicans and the economy briefly sputtered into a double-dip recession as a result.

Republicans take the same position with President Obama's initial stimulus plan, which the non-partisan Congressional Budget Office credits with creating or saving up to 3.3 million jobs and lowering unemployment by 1.8 percent. This is a view supported by Moody's Chief Economist, although Moody's Chief Jane Austen scholar has not opined on the matter.

Unfortunately, in today's media the fact that the Republican Party holds a contrary view on the stimulative effect of the New Deal and/or the success of the Obama stimulus (even if it is one that is plainly contradicted by the evidence) not only renders this a debatable point; but its constant repetition by the GOP elevates it to conventional wisdom (which apparently is sufficiently authoritative for S&P).

The same is true for the GOP position that tax cuts for the wealthy have a greater stimulative effect and pay for themselves, a point debunked by David Stockman, the architect of the Reagan tax cuts, who called the Bush tax cuts "the worst fiscal mistake in history."

Richard C. Koo, a leading authority on recessions and Chief Economist for Nomura Research, points to Japan's experience in the 1990's (its so-called "Lost Decade") in which government stimulative efforts both improved economic performance and helped reduce the deficit while austerity measures failed. Koo contends that the U.S. economy needs further stimulus and that the adoption of the spending cuts called for by S&P "would plunge the economy into another Great Depression" and "destroy the global economy." This is not hyperbole, as the austerity program adopted by Great Britain's new Conservative government halted a weak recovery and has plunged the nation into its worst downturn since the depression.

Koo is not alone is his belief that further stimulus is needed, as none other than Federal Reserve Chairman Ben Bernanke (a Bush appointee) has argued that further stimulus was required to keep the economy growing. Bernanke also has warned that the Republican austerity measures would result in substantial job losses (as much as 700,000 according to Moody's estimates).

Few people, however, fault S&P for its analysis that the debt ceiling negotiations were a debacle. A Republican friend of mine who travels worldwide for business expressed his disgust over the manufactured crisis; noting that while China and other countries are investing in their economies and moving forward we are standing still adhering to "conventional wisdom" and allowing our infrastructure and competitiveness to continue its steady decline.

Yet when Congress returns in September with nearly 14 million Americans unemployed and the nation standing at an economic precipice, S&P's downgrade ensures that the debate will be dominated by the "conventional wisdom's" calls for spending cuts and not the need for further stimulus (despite the absence of any economic model showing that austerity during a weak recovery leads anywhere but disaster). That is why any proposals from the new Congressional Super Committee should be scored by the Congressional Budget Office for the jobs it creates or destroys and not just the pennies it saves.

With S&P now part of the cacophony drowning out any response based on sound economic principles, it is evident that the deficit that most threatens our nation is factual not fiscal; and that our economic prospects are burdened more by denial than by debt and our growth is impeded by a lack of political courage as much as it is due to a lack of capital. As the nation emerges from its own lost decade, it is time for common sense and unconventional wisdom. Unfortunately, S&P's decision merely confirmed that both remain in short supply.